November 18, 2009

So Ontario has set course towards adopting the HST. While the HST itself seems to be this ominous change in the province's tax system that will screw over everyone by increasing prices across the board and force Ontarians into the poor house. At least, that is the portrayal that a couple media places would have you believe, such as Global. The truth is that we don't know what's going to happen. The theory behind this plan says the opposite but then again, theory doesn't always work out the way we expect.

The problem with their reporting on the issue is that the HST is one part, albeit a large part, of a bigger plan. However, talking about the entire plan and explaining the details doesn't make for nicely packaged sound bites. And apparently neither does explaining that this whole thing is a partnership with our federal government.

I had the opportunity to hear an MPP explain other parts of the plan as plain as possible. I will attempt to do the same here. First, let me say that I'm still taking a wait-and-see approach towards this entire plan (not that I have a choice since it's going ahead whether I agree with it or not). It can be explained simply without big numbers and jargon only a chartered accountant would understand but even then it's still long-winded.

One of the most common arguments being thrown out in favour of the HST plan is that corporations will save time and money by only having to do one set of taxes. That is true, but the real value doesn't exist there. The real savings for businesses is that much of the taxes that are paid through the supply chain will be neutralized.

What do I mean by 'neutralized'?

Let's consider a simple supply chain:

raw materials --> manufacturer --> wholesaler --> retailer

Currently, there is a tax paid between each sale. So when the manufacturer purchases the raw materials they pay tax on that purchase. When the wholesaler purchases the goods from the manufacturer they pay tax on that transaction. And so on. This tax often ranges somewhere 2% and 5%. And since each player wants to recoup the tax they pass this cost along to the next person by embedding it into the cost of the item. Using the above chain and 2% tax at each step, by the time the item gets into the hands of the consumer, 6% of the item's price is embedded tax passed upward along the chain by each player.

Given that the above supply chain is over-simplified the reality is by the time the consumer purchases an item and pays GST and PST, generally anywhere between 21% and 38% of the final cost is made up tax. Whether this is sales tax or tax already paid and being recouped by those in the chain, any given commodity is much higher than its true retail value.

In part, by moving to the HST, along with other changes, these embedded taxes should disappear. This is due to the HST being considered a value-added tax and therefore businesses along the supply chain not being subject to it or them being able to claim those costs back in taxes. So where we currently see about 21% to 38% of an item being tax, this will be scaled back to just %13 - the HST being paid by consumers. The theory behind this is that since businesses will no longer be paying those taxes, they will pass the savings along with their products effectively lowering the price of consumer goods.

This is where skepticism prevails as many just don't believe the savings will reach consumers. While it may take some time for those savings to be seen, there is much optimism within the Ontario Liberals that it will come. This optimism comes from that fact that there is serious competition for consumers' money in Ontario. Companies such as Wal-Mart, Zellers, Loblaws, and Canadian Tire are currently in a huge fight to bring costs and prices as low as possible to attract more customers. Once one of these companies take advantage of being able to advertise even lower prices, they will all follow suit. And once the discount retailers go, eventually the mid-level retailers will too. And so on. That's the theory, anyway. Considering the fight between Wal-Mart, Zellers and Loblaws especially, it's highly plausible it will work out.

Now services are another thing. And as far as I can tell, there is some nervousness amongst the Ontario Liberals over whether or not savings will be passed here. Since most service providers are less obvious about how they are affected by the supply chain, any savings they experience can be much easier pocketed. Even though their businesses taxes will be lower, the items they purchase will be cheaper, they don't have to do anything. Even though the theory is that any savings they experience will be passed along to customers to offset the newly applied 8% HST increase, they likely won't because there is much less pressure to do so. Instead customers just pay the extra 8% and claim they're paying more for the service due to taxes.

However, that is what the tax rebate and credits are for. Each of us will be getting $620 tax credit on our income and those that make under $80000/year will get a rebate for up to $1000. Between these two measures, any cost increase we see when paying for a service should be more than offset. In fact, unless we're spending more $12500 on services in a given year, we'll actually come out ahead. Or so goes the thinking on the part of the Liberals.

The biggest justification for the HST plan is that it brings our tax system in line with most European nations that are looking to Canada for trade and growth. Apparently our current tax structure is seen as a deterrent, either due to its complexity or the costs that are placed on businesses, goods and therefore consumers. By going to the simplified HST program along with the elimination of embedded taxes it makes Ontario a much more attractive place to invest which will in turn create jobs, competition, etc.

Long explanation but simply put. Even in simple terms - an explanation without big numbers, accountant-speak, etc. - it takes some time to talk about. The talk I heard took an easy 45 minutes and there was still more to discuss. Even here, I haven't touched upon everything. That makes it hard for the media to discuss as well. And even though I'm taking a cautious approach to judgment on this, I still find media like Global frustrating when they premise every HST news clip with 'the price on everything is going to increase' or 'prepare to pay more tax' when the reality has yet to play out.

"First it is necessary to stand on your own two feet. But the minute a man finds himself in that position, the next thing he should do is reach out his arms. " ~ Kristin Hunter

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